Indian Firms Assume Higher Forex Risk In 2023 Following RBI's Backing

In 2023, Indian importers and exporters chose to leave a larger portion of their foreign currency exposures unhedged, relying on the Reserve Bank of India (RBI) to maintain the rupee in a narrow range. According to data from Clearing Corp of India, forward contracts purchased by importers to hedge future foreign currency payments decreased by 14.5 per cent year on year, while hedging by exporters declined by 12.5 per cent.

Forward contracts, the most commonly used derivative instruments for hedging, saw a more significant drop of 20 per cent to 25 per cent, according to a senior FX salesperson at a private bank. He mentioned that companies, especially larger ones, are finding value in using fewer forwards in the current economic climate.

A small portion of hedging through forwards has been replaced by options, the salesperson added. India's total imports and exports between January and November 2023 declined by 8 per cent and 5 per cent, respectively, compared to the same period the previous year.

Last year, the Reserve Bank of India (RBI) intervened regularly in the spot and forward markets, resulting in reduced intraday swings and overnight risks on the rupee. 

This intervention made the rupee one of the least volatile Asian currencies, with volatility expectations dropping to their lowest in 15 years. Throughout the year, the currency remained stable within a narrow 3.5 per cent band, reducing to a mere 1% band in the December quarter.

Ashutosh Tikekar, the head of global markets at BNP Paribas India, noted that the RBI actively managed the currency movement throughout the year. He added that a stable FX environment and reduction in carry helped clients under-hedge without worrying much about profit and loss.

Tikekar, a financial expert, stated that India's significant foreign exchange reserves give clients confidence that the Reserve Bank of India will continue with its current foreign exchange policy in the near future.

Carry refers to the profit earned by holding a high-yielding currency compared to a low-yielding one. Due to the recent hike in US interest rates, the carry-on of the dollar/rupee pair hit a 15-year low in November.

Low carry rates discourage exporters from hedging in the forward market. On the other hand, importers are encouraged to hedge more when the carry rate is low but not when the currency is stable, according to bankers.